Neumann-Morgenstern Statistical Theory
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Neumann-Morgenstern Statistical Theory

Neumann-Morgenstern Statistical Theory There has been a neo-cardinalist revival in recent years as represented by 'he works of Oskar Morgenstern and John Von Neumann. The demand theory formulated by them is considered' applicable to situations involving measurable risk. It’s a statistical theory, because it is based on a number of observations and not on a single act of choice as in Samuelson's or Hicksian theory.

Neumann-Morgenstern Statistical Theory

There has been a neo-cardinalist revival in recent years as represented by 'he works of Oskar Morgenstern and John Von Neumann. The demand theory formulated by them is considered' applicable to situations involving measurable risk. It’s a statistical theory, because it is based on a number of observations and not on a single act of choice as in Samuelson's or Hicksian theory.

In statistical terms, we can have both strong and weak ordering. For example, if a person always chooses P situation rather than Q situation. P is preferred in a strong sense. Also if he always chooses Q rather than R, then Q is strongly ordered. But between the situations like P (in which Q is never chosen) and situations like R (in which Q is never chosen) and situations like R(in which Q is never rejected), there may exist a number of intermediate situations in which Q may be accepted or rejected. We shall not, therefore, be able to predict the consumer's choice in such situations and we may say that he is in a state of indifference, which is a case of weak ordering. Samuelson's behavior theory, therefore, cannot rationally predict individual behavior.

When, however, an individual's choice is repeatedly observed over a set of samples of minimum size, some sort of consistency is established and the way is prepared for the statistical preference hypothesis. The Neumann-Moregenstern theory admits the concept of indifference but only by ruling out the requirement of single-events consistency. Thus, it is a hypothesis of 'weak' but consistent preference (indifference).

It is based on two possible assumptions: (a) the consumer is unable to distinguish clearly between two objects, so that he chooses (rejects) only hesitatingly with the result that the choice sometimes turns out to be undesirable, (b) The consumer does .not regard the two objects of his choice as 'sure prospects' and that there is an element of risk of not having one or the other The existence of risk explains the phenomenon of weak preference, i.e. the choice frequency is less than 100 per cent. The frequency of choice would vary inversely with the degree of risk. Given the degree of risk, the frequency of choice would vary with intensity of preference. This frequency serves as a measure of relative preference under conditions of risk. That is, "under conditions of measurable risk, the individual expresses his relative preference in terms of frequency of his choices."

 

The neo-cardinalist demand theory is simply this: A "consumer is expected to evaluate his 'prospects' in terms of statistical  probability, and judged over a larger number of cases, to appear to maximize the statistically expected value of his ‘utility’.

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